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Canadian M&A Market Recap: Week Ended February 10th

Sixty-two Canadian M&A transactions were announced this past week. Year to date, M&A deal count has been nearly 10% greater than 2016. The Canadian dollar fell by 0.43 cents, ending the week at 76 cents.

The new issue environment for U.S. middle market loans remains robust, with average total leverage of 4.7x EBITDA, while new issue clearing yields are 0.54% greater than last year’s levels. Total leverage levels fell by 0.2x from last week and have decreased 0.9x from one year ago indicating a tighter lending market.

Tariffs, Taxes and Trump: U.S. Border Adjustment Tax…the other threat to our Canadian economy

“NAFTA is the worst trade deal maybe ever signed…” The pervasive “trumpeting” of that rhetoric was heard throughout the recent U.S. election campaign. Finger pointing about unfairness in the context of North American trade was primarily directed at Mexico, with Canada sitting quietly on the sidelines. And, in fact, since the new administration has taken the reigns, there have been assurances that Trump is happy with the trade relationship with Canada[1].

But what does that mean? If a renegotiated NAFTA reflects the new administration’s favourable view of Canada, do we get a free pass on U.S. protectionism? The answer is likely no. There is a second, less discussed, impediment to Canada’s economic well being: the border adjustment tax (BAT), part of the U.S. corporate tax reform proposed by House Speaker Paul Ryan and Ways & Means Committee Chair Kevin Brady. The plan supports a cut in U.S. corporate tax from 35% to a flat 20%, with the use of a BAT to generate additional tax revenue.

What is a border adjustment tax?

The BAT differs from a tariff in that it is a consumption tax, paid by the end consumer. The proposed U.S. plan would apply a 20% BAT to all imported goods. Revenue generated by U.S. businesses from exports would not be subject to the BAT. In effect, it is a tax on the U.S. trade deficit.

In the following example, we illustrate the application of the proposed U.S. tax regime for three U.S. companies. For simplicity, we assume that cost of goods sold (COGS) are comprised entirely of raw materials. In practice, the BAT is an evolving and complex issue that isn’t entirely captured by our simple example. Of course, we are not tax experts. However, we would be pleased to connect you to an experienced tax professional if you would like a more nuanced explanation.

The above three scenarios are defined by how each company affects the trade balance with other countries. The Local company does all its business in the U.S. with no impact on the trade balance, and therefore, can subtract U.S. COGS from its revenue to calculate taxable income. The Exporter, on the other hand, contributes to a trade surplus, which exempts its revenue from taxable income. Conversely, the Importer contributes to a trade deficit and therefore cannot subtract Foreign COGS from revenue in calculating taxable income.

And the consequences?

The obvious, immediate consequence will be an increase in the cost of imports to U.S. buyers. There will be an impact on Canadian exporters, as their U.S. trading partners would have to pay the BAT on any Canadian exports, thus driving up price of those goods. This, in turn, will translate into downward pricing pressure (i.e. a 20% pricing decrease to offset the negative impact to the U.S. importer) or decreased demand for Canadian exports to the U.S.. U.S. sectors that have high net imports will be hardest hit, including retail, auto (also facing a looming threat with the renegotiation of NAFTA), and oil and gas. In response, a lobby group called the Americans for Affordable Products Coalition (AAPC) was recently formed to protest the tax, claiming that it will raise the cost of everyday items such as gas and food. The group includes large retailers (Macy’s, Target), and trade associations.

If the BAT becomes a reality, some economists are predicting an increase in the value of the U.S. dollar by as much as 25%, which would effectively render neutral the increased cost of imports. The magnitude of increase is a topic of much debate, however, and it is unclear at this point what the net impact will be.

Oil and Gas: A sector snapshot

While energy shares surged following Trump’s election victory, the spectre of a BAT has quashed that early exuberance. Canadian producers are concerned, as they export approximately 3 million barrels of crude per day to the U.S., representing about three-quarters of Canadian production. U.S. oil refineries certainly oppose the BAT; several major mid-west refineries (Koch, Exxon Mobil, BP, Husky Energy) run facilities built to process Canadian crude oil. Recently, there has been some suggestion of an exemption for crude oil, but the uncertainty remains, and will continue through the summer, as the U.S. Congress considers the proposed tax reform bill.

What’s next?

Unlike a potential NAFTA renegotiation, Canadians have no direct role to play where the BAT is concerned. We simply have to wait and see what Congress does with U.S. tax reform. Unfortunately, the uncertainty will overhang much of 2017. A recent Nanos poll indicated that 58% of Canadians would support a trade war in response to any new U.S. “tariffs”. That would be a mistake. A C.D. Howe Report released last month suggests that while Canada will be worse off with a U.S. border tax, trade retaliation would only further damage the Canadian economy. We should, rather, focus on the limited positives, in the event the BAT is implemented: the possibility that crude oil will be exempt (as the U.S. needs our production to meet their demand), and the benefits to manufacturing that would flow from a lower Canadian dollar. And finally, there is the takeaway lesson for us to contemplate: that our government, in conjunction with Canadian exporters, should continue to invest concerted effort into the development of non-U.S. trading relationships.

What are the M&A implications?

While the likelihood, timing and net impacts remain unknown, Canadian companies that derive significant revenue from U.S. corporations would be impacted by the BAT. To the extent that owners of any such companies are considering a sale, we encourage them to seek professional advice on how this tax uncertainty may impact the value of their companies and the likelihood that their sale processes will be successful in the current climate. Such advice may impact value expectations and result in holding these companies off the market until the uncertainty is resolved.

For those who are considering M&A in the coming months and wish to discuss this further, we would be pleased to assemble a team of experts to assist shedding light on their particular circumstance.

M&A Deal Summary

Announced Deals

Manulife Financial to Acquire DBS China Square

Manulife Financial Corporation (TSX:MFC), a Canadian company that provides financial and insurance services internationally, has agreed to acquire DBS China Square Ltd., a Singaporean company that was a subsidiary of DBS Bank Ltd. Total transaction value is estimated to be $329 million.

Valens Groworks to Acquire Supra THC Services

Valens Groworks Corp. (CNSX:GEC), a Canadian company that cultivates and researches cannabis, has agreed to acquire Supra THC Services Inc., a Canadian company that offers licensed cannabis testing laboratory services. Total transaction value is estimated to be $3.8 million.

Valens Groworks to Acquire Island Green Cure

Valens Groworks Corp. has also agreed to acquire Island Green Cure Ltd., a Canadian company that researches and develops marijuana for medical purposes. Total transaction value is estimated to be $2.5 million.

Public Sector Pension Investment Board and Teachers Insurance & Annuity Association of America, Endowment Arm, a U.S.-based government owned pension fund, have agreed to acquire Vantage Data Centers Management Company LLC, a U.S.-based company that develops data centers. No transaction terms were released.

Sora Capital to Acquire ProSmart Sports Development

Sora Capital Corp. (TSXV:SOR), a Canadian private equity and venture capital company, has agreed to acquire ProSmart Sports Development, Inc., a Canadian company that operates an online platform connecting hockey players to educators. Total transaction value is estimated to be $5.7 million.

ETAS Embedaded Systems Canada Inc., a Canadian company that provides safety and security solutions for embedded and automotive systems, has agreed to acquire TrustPoint Innovation Technologies, Ltd., a Canadian company that offers elliptic curve cryptography authority services. No transaction terms were released.

The Canadian Bioceutical to Acquire PerkAZ Property

The Canadian Bioceutical Corporation (OTCPK:CBIC.F), a Canadian manufacturer and distributor of bioceuticals and nutraceuticals, has agreed to acquire PerkAZ Property LLC, a U.S.-based company that operates land for cultivation of cannabis. No transaction terms were released.

High Hampton Holdings to Acquire Coachellagro

High Hampton Holdings Corp., a Canadian company that acquires licensed marijuana producers, has agreed to acquire Coachellagro Corp., a U.S.-based company that operates a full-service production facility for medical marijuana. Total transaction value is estimated to be $3.9 million.

Fireswirl Technologies to Acquire Amzon

Fireswirl Technologies Inc. (TSXV:FSW), a Canadian company that provides technology and service platforms for e-commerce sales in China, has agreed to acquire Amzon (HK) Ltd., a Hong Kong company that designs and creates interactive multimedia solutions. Total transaction value is estimated to be $1.2 million.

Nass Valley Gateway to Acquire IXI Treasury Holdings

Nass Valley Gateway Ltd. (DB:3NVN), a Canadian company that acquires and explores mineral properties, has agreed to acquire IXI Treasury Holdings Ltd., a Hong Kong company that manages an investment portfolio. No transaction terms were released.

Enterprise Castle Hall Alternatives to Acquire SwissAnalytics

Enterprise Castle Hall Alternatives Inc., a Canadian company that provides operational due diligence services to the investment management industry, has agreed to acquire SwissAnalytics AG, a Swiss-based company that provides due diligence advisory services for hedge funds. No transaction terms were released.

Fusion RMS to Acquire Innovantum Technologies

Fusion RMS, a U.S.-based company that provides a retail management system, has agreed to acquire Innovantum Technologies Ltd., a Canadian company that provides strategy planning, marketing and technology development services. No transaction terms were released.

Closed Deals

Kontrol Energy Acquires ORTECH Consulting

Kontrol Energy Corp. (CNSX:KNR), a Canadian company that provides energy saving technologies, has acquired ORTECH Consulting Inc., a Canadian company that provides technology-based consulting services in North America. Total transaction value is estimated to be $4.6 million, implying a 4.9x EBITDA multiple.

HomeAdvisor Acquires HomeStars

HomeAdvisor, Inc., a U.S.-based company that provides an online platform to connect home owners and home improvement companies with service professionals, has acquired HomeStars, Inc., a Canadian company that operates a similar online platform. No transaction terms were released.

Prophecy Platinum Acquires URSA Major Minerals Incorporat

Prophecy Platinum Corp., a Canadian mineral exploration company, has acquired URSA Major Minerals Incorporated, a Canadian company that mines, explores, and develops mineral resource properties in Canada. Total transaction value is estimated to be $200 thousand.

Russell Hendrix Foodservice Equipment Acquires Guitech Services

Russell Hendrix Foodservice Equipment, a Canadian distributor of food services equipment, has acquired Guitech Services Inc., a Canadian company that provides maintenance and repair services for the foodservice equipment market. No transaction terms were released.

Motivate Acquires 8D Technologies

Motivate, a U.S.-based company that designs and manages bicycle sharing systems, has acquired 8D Technologies Inc., a Canadian company that designs and develops point of sale (POS) hardware and software solutions. No transaction terms were released.

Imperva, Inc. (NasdaqGS:IMPV), a U.S.-based company that provides cyber security solutions, has acquired Camouflage Software Inc., a Canadian company that develops data management and security software. No transaction terms were released.

TS BrandCo Holdings Acquires Van der Pop

TS BrandCo Holdings Inc., a Globalive Capital Inc. backed Canadian company manufacturer and retailer of coffee, clothing, and cannabis, has acquired Van der Pop, a U.S.-based designer and manufacturer luxury accessories for cannabis. No transaction terms were released.

Presteve Foods Acquires La Nassa Foods

Presteve Foods Limited, a Tricor Pacific Founders Capital Inc. backed Canadian company that processes and supplies fish products internationally, has acquired La Nassa Foods Inc., a Canadian company that processes and supplies seafood products. No transaction terms were released.

Beazley plc (LSE:BEZ), a U.K.-based company that provides risk insurance and reinsurance solutions internationally, has acquired Creechurch International Underwriters Ltd., a Canadian insurance underwriting company. No transaction terms were released.

Canada Brokerlink Acquires Lanoue Insurance Brokers

Canada Brokerlink Inc., a Canadian brokerage of property and casualty insurance, has acquired Lanoue Insurance Brokers Ltd., a Canadian company that provides insurance brokerage services in Windsor and Essex in Ontario. No transaction terms were released.

NetAccess Systems Acquires Sunpark Consulting Group

NetAccess Systems, Inc., a Canadian internet service provider to organizations, has acquired Sunpark Consulting Group, Inc., a Canadian company that provides information technology (IT) consulting services. No transaction terms were released.

Paladin Security Systems Acquires Marcomm Systems Group

Paladin Security Systems Ltd, a Canadian security services company, has acquired Marcomm Systems Group Inc., a Canadian company that develops facility systems integration software. No transaction terms were released.

Paladin Security Systems Acquires CONTAVA

Paladin Security Systems Ltd, has also agreed to acquire CONTAVA Inc., a Canadian company that services enterprise information technology security systems. No transaction terms were released.

Multi-Bookbinding Acquires Spiraplast

Multi-Bookbinding, a Canadian company that offers binding services, has acquired Spiraplast Inc., a Canadian company that manufactures PVC and plastic wires. No transaction terms were released.

[1] Stephen Schwarzman, who heads President Trump’s strategic and policy forum, spoke to the federal cabinet in Calgary on January 23, 2017, and said “trade between the U.S. and Canada is really very much in balance and is a model for the way that trade relations should be.”